EBRI Shows Risk in Taking CRDs and Loans

An Employee Benefit Research Institute (EBRI) study has found that taking withdrawals under the Coronavirus Aid, Relief and Economic Security Act (CARES) Act can have damaging effects on workers who fail to repay them, especially those in older age groups.

While those who fully refund their coronavirus-related distributions (CRDs) are projected to see minimal impact on their future retirement security, those who do not repay the distribution face the possibility of significant reductions in their retirement balance.

The report offers four scenarios, each painting a different impact in taking out a CRD.

The first includes a one-time full withdrawal—up to $100,000—with a three-year payback, which resulted in a median reduction rate in retirement balances of 2.3%. However, that figure more than doubles, to 5.8%, for older workers ages 60 to 64.

The second scenario is one in which a worker takes a full distribution but instead of repaying it over the course of three years, does not pay back the withdrawal at all. In this scenario, the EBRI report finds the median reduction skyrockets to 20%, and again more than doubles for older workers, at a 45% reduction rate in retirement balances. This rate is cut in half to 10% for younger workers, most of whom have account balances that are too small for a full distribution.

In the third setting, the report assumes that every dollar used to repay the CRD will result in a dollar reduction toward new contributions to the defined contribution (DC) plan account. This results in a median reduction of 5.9% overall, and an 8.8% reduction for workers ages 55 to 59, and 5.5% for those 60 to 64.

The last situation shows a more draconian scenario, as the report notes, in that an employee takes on a full CRD in 2020 and further does so every 10 years thereafter with no payback. This scenario represents a potential national or global crisis, such as the current pandemic or the 2008 recession, that occurs every 10 years. In response to these crises, policymakers would relax withdrawal provisions within DC plans, says the report. Such a scenario concludes with the highest reduction rate of the four scenarios, at 54%—a loss of more than half of retirement account balances. According to EBRI, at this point, the median reduction rate no longer increases with age as with the other scenarios, since the number of withdrawals is larger for younger participants.

Jack VanDerhei, EBRI’s director of research and author of the report, explains that the study warns about the consequences of using DC plans as an emergency savings account, all while highlighting further examination of the loan provisions. “While the CARES Act provisions provide much-needed liquidity for cash-strapped workers during the current pandemic, this study strives to assess how using defined contribution plans as emergency savings impacts the future retirement security of American workers,” he states. “However, further examination is needed. Under a scenario in which estimated actual implementation and utilization of CARES Act provisions is low, the aggregate impact is estimated to be less than one-half a percent in the scenario in which employees fail to pay back CRDs. But that could change if more employers choose to implement provisions or if allowing access to retirement funds with no penalty becomes a more commonplace and relied-upon response to emergencies.”

The report makes it a point to add that employers would have had to offer these provisions in their plan, with employees requiring approval before taking out such a distribution. The CARES Act distribution and loan provisions have been met with several reviews since their introduction. And plan sponsors have considerations to understand before implementing loan options.

Attorneys have urged advisers to warn their plan sponsor clients about ineligible usage of distributions and loans. A participant who takes advantage of the options but who was not financially impacted by COVID-19 can be subject to significant consequences, including substantial penalties.

Robert Lawton, president of Lawton Retirement Plan Consultants goes further and suggests  that plan sponsors should not adopt plan distributions. If the plan sponsor believes their plan population has not experienced an adverse financial impact as a result of the pandemic, the prudent course of action is to refrain from permitting the distribution, he says.

“You should know that the CARES Act does not require participants who take these withdrawals to show evidence of financial hardship or loss, as would be required under normal hardship withdrawal provisions,” Lawton said in a June interview with PLANADVISER.

Still, if an employer feels the need to offer an option under the CARES Act, Lawton asks employers to consider adopting the loan provision instead.

“If you feel you need to provide greater employee access to plan balances, and your plan permits loans, consider adopting the relaxed CARES Act loan provisions instead of the withdrawal provisions,” Lawton advises. “While I normally don’t favor 401(k) loans, they are a better option than withdrawals during this pandemic.”